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The string of bad news for West Penn Allegheny Health System continued on Thursday as the nearly bankrupt hospital operator reported both a $24.7 million quarterly loss and that it might face a Securities and Exchange Commission lawsuit.

The SEC, which started investigating Pittsburgh's second-largest hospital system in 2008 over an accounting error, issued West Penn Allegheny a notice on Tuesday that federal investigators “recommend the commission bring a civil injunctive action” against the system.

West Penn Allegheny disclosed the notification, known as a Wells Notice, in a report on its July-September financial results. Board Chairman Jack Isherwood told employees in an email that the notice gives the system a chance to argue against legal action.

“We intend to file such a submission with the SEC, setting forth the basis for the system's belief that action is not warranted,” Isherwood wrote.

West Penn Allegheny cooperated with the SEC's four-year investigation, which began after the hospital system admitted to inflating revenue by $73 million.

The system restated its financial results for the year ended June 30, 2008, leading to a net loss of $62.8 million for the year.

Officials said at the time that the error occurred because the hospital system implemented new accounting procedures.

“Wells Notices are like the 11th-hour notice before the trip to the gallows begins,” said Douglas Branson, the W. Edward Sell Professor of Business Law at the University of Pittsburgh.

Although receiving such a notice does not guarantee the SEC will sue, Branson said, it indicates investigators believe they found enough evidence of intent to deceive bond investors, who hold about $750 million in hospital debt.

After receiving West Penn Allegheny's response, the five-member commission will vote on whether there's enough evidence to pursue a lawsuit, he said. “If they are accused of cooking the books, the commission would have to prove a state of mind that shows intentional conduct.”

The SEC declined to comment.

If the SEC sues, West Penn Allegheny is likely to settle and pay a fine because it cannot risk losing the case, Branson said. A loss would open the system to a flood of lawsuits by its bondholders.

“Very few companies go to trial against the SEC,” he said.

While dealing with ongoing losses and now the possibility of SEC action, West Penn Allegheny is trying to close a deal to be acquired by Highmark Inc., the state's largest health insurance company.

In his letter to employees, Isherwood said the system “continues to meet with Highmark on a very frequent basis.”

The two sides are trying to come up with a plan that reduces the system's projected financial losses so that the state Insurance Department will approve the acquisition.

West Penn Allegheny accused Highmark of demanding that it enter Chapter 11 bankruptcy to reduce its $1 billion in debt.

Highmark officials declined to comment.

Higher expenses and declining patient volume caused West Penn Allegheny's loss in the July-September quarter, which begins its 2013 financial year. Revenue in the three-month period increased 2 percent to $378.2 million because of contractual increases in reimbursement rates from insurers and from offering more medical services at West Penn Hospital in Bloomfield.

Expenses jumped 3 percent to $406.4 million on higher costs for salaries and supplies.

The higher expenses led to an operating loss of $28.3 million, including $33,000 in restructuring charges, which compares with an operating loss of $25.2 million, including $1.9 million in restructuring, in the same quarter last year.

“While we are doing an outstanding job of reducing costs, we are seeing higher salary expenses as we employ more physicians and hire more staff for our new programs,” Isherwood wrote. “This is a strategic decision, which we believe will yield benefits in the future.”

Alex Nixon is a staff writer for Trib Total Media. He can be reached at 412-320-7928 or anixon@tribweb.com.

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